By Yves Smith, a management consultant, corporate finance advisor, and creator of the blog Naked Capitalism. This article was cross-posted from Naked Capitalism.

Even more so than most cities, Chicago has had the best government money can buy. In this case, the money is willing to engage in a scorched-earth policy of crushing local investors and wrecking the city budget to achieve its end of taming unions and making Chicago even easier pickings for looting via infrastructure sales.

The backdrop is that the city was hit with a stunning three-ratings-notch downgrade by Moody’s last week, from AA3 to A3. As the Chicago Sun-Times stressed, that sort of drop is unheard of absent a natural catastrophe. From the article (hat tip Joe Costello):

“You don’t usually see a triple-downgrade unless there is a catastrophic event, such as a natural disaster or terrorist attack,” said Civic Federation President Laurence Msall.

“This is a financial hurricane event for Chicago. … The city’s borrowing costs will rise dramatically and their ability to use creative financing is going to be limited because of the costs associated with having such a low rating.”

The bond rating at the Chicago Public Schools has dropped repeatedly since Emanuel took office, but Thursday’s triple-drop was the first impacting the city’s bond rating.

“The current administration has made efforts to reduce costs and achieve operational efficiencies, but the magnitude of the city’s pension obligations has precluded any meaningful financial improvements,” Moody’s wrote

Emanuel responded by essentially saying, “I told you so.”

The immediate loser are local investors, since municipal bonds are generally owned by people in the immeidate area, and the city, since it will face higher borrowing costs. So why is Rahm so smug, and why was he so keen to see a downgrade? Normally corporate CEOs and city managers tout the prospects of their charges and want them to have the most favorable borrowing costs.

But the big point of friction has been Chicago’s underfunded pensions, the rest of over ten years of the city failing to contribute enough annually. And Rahm, rather than trying to find equitable solutions, has instead been playing hardball from when he took office:

Last year, Emanuel blindsided and infuriated union leaders whose collaboration he had promised to seek to solve the pension crisis.

Instead of negotiating first with union leaders in Chicago, he went to Springfield to lower the boom. The following day, he sent a letter to city employees to soften the blow of the bitter pill he’s asking them to swallow: a 10-year freeze in cost-of-living increases for retirees; a five-year increase in the retirement age; a 5 percent increase in employee contributions and a two-tiered pension system for new and old employees.

Labor leaders accused the mayor of pitting hardworking employees against taxpayers by portraying a 150 percent increase in property taxes as the only alternative to employee concessions.

In the end, Chicago’s pension crisis was put off along with state’s $83 billion pension problem as lawmakers continued to grapple with rival plans championed by House Speaker Michael Madigan and Senate President John Cullerton, both Chicago Democrats.

With that background, here’s the next piece of the story: local CEOs have been pushing the rating agencies for downgrades. Watch this video starting at 47:00. The speaker is Ty Fahner, the head of the Civic Committee of the Commercial Club of Chicago. Members include the union-busting Pritzers, both Penny and Thomas, a long list of current and recent corporate CEOs and chairmen, influential members of the banking and real estate industries, partners from major law firms, and Rahm as an “honorary members”. This is a Who’s Who of business Chicago.

Not only was Fahner open about how aggressive the lobbying by the CEOs for the downgrade had been, and didn’t disagree with the questioner who called it irresponsible (as in “we know we are doing harm to promote what is good for us”), he said they’d had to back off because they didn’t want their handiwork to be too visible, and was exhorting people in the room to take up the campaign for him.

So here we have it: city fathers working to wreck a city budget so their companies will benefit from more tractable, as in more broke, local workers.

I asked a colleague who had worked for Moody’s in the 1990s why outside parties were allowed to influence ratings. His reply via e-mail:

When I was at Moody’s, a substantial majority of the rating downgrades or upgrades that took place were initiated by an outside investor inquiry.

These days, it’s big business for investors to research a bond, conclude that it should be upgraded or downgraded, take the appropriate position in the bond, and then lobby the rating agency to make the move that is supported by their research, and profit from the change in market value (or market to model valuation) that accompanies the rating change.

Since rating agencies have historically invested virtually nothing in surveillance, it is not hard for a diligent investor to be ahead of the rating agency action. Once the rating agency gets the info on the bond, it is very hard for the rating agency to ignore the information.

So these Illinois business leaders are just applying the same techniques that people at Third Point, Paulson, Elliot, etc. have been applying for years. (Not only that, the rating agencies use the same approach against competitors- if they hear from investors/issuers that a competing rating agency is doing something too aggressively, they call it into the SEC – which is what happened to Egan-Jones).

When I first read about the downgrade, my reaction had been that Rahm must have pushed for it. My colleague had a similar reading:

Also, I’m pretty sure I read in last couple of days that Rahm himself lobbied Moody’s to downgrade his state. I think that’s pretty fucked up, but I’m sure his hedge fund buddies taught him all about it. It’s about as evil as I would expect from Rahm as an elected politician.

Nothing has changed with the current corrupt ratings system because it serves too many powerful interests too well. Jane Hamsher, based on a detailed construction of when S&P became a big scaremonger over US deficits and downgraded the US (which was supposed to End the World as We Knew It but as we predicted, didn’t), made a persuasive case that the ratings agency took this stance to ward off regulatory action. Had the US downgrade produced the bond yield blowout that the financial media was convinced would happen, it’s a near certainty that Obama would have gotten his Grand Bargain and Social Security and Medicare would have been trimmed in a serious way. You can expect more drumbeating about the US rating as Obama makes another Grand Bargain push (the biggest upside of the Edward Snowden revelations may not be any curtailment of the surveillance state, but forcing Obama to divert so much political capital to that fight that he doesn’t have enough chips left to push through Medicare and Social Security whackage).

As our former ratings agency staffer concluded:

It is unreasonable to expect that anything would have gotten better with the rating agencies when nothing has been done to change anything. If elected officials really wanted this sort of thing to stop, they would actually, you know, do something. It is clear that they are happy with the current system, which includes a lot more lobbying activity from the big three than it did in the past.

And increasingly, one of the pet political uses is for ratings to serve, as the questioner indicated in the video, to create the illusion that “the market” is insisting on austerity, when powerful people are rigging the process. Cross-posted from Naked Capitalism.

The FBI confirmed that a Task Force from the FBI, the IRS, the District Attorney’s Office, and the US Attorney’s Office is investigating political campaign corruption in Orange County, California. A Democrat Attorney General targeting powerful Republican politicians in America’s most Republican county? Um, the District Attorney on the Task Force himself is a Republican. Read.... FBI Investigating Orange County, California, Supervisors

Wolf here. I would love to hear from you. You can send me an email to:

testosteronepit [at] gmail.com

I will post some of the comments, articles, corrections, points of contention, etc. under the tab “Readers Speak Up,” if I find them relevant, interesting, awesome, civilized, etc. Funny is always good.

- Include the title or link of the article you’re responding to.

- Let me know the name (alias is ok) under which you want me to publish your writing.

- If you have a blog, include a link (self-promotion is ok)

- I’ll try to send you confirmation once it’s published.

- If you DON’T want me to post your writing, if you want me to keep it private, please let me know!